Business Finance Chapter 10 Notes

Business Finance Chapter 10 Notes 1. When developing cash flows for capital budgeting, it is easy to overlook important items. 2. The first step is to determine whether cash flows are relevant. 3. Incremental cash flows come about as a direct consequence of taking a project under consideration. 4. According to the stand-alone principle, once the incremental cash flows from a project have been identified, the project can be viewed as a "minifirm." 5. Sunk costs are costs that have already occurred and are not affected by accepting or rejecting a project. 6. Opportunity costs are lost by accepting a project. 7. The first step in estimating cash flow is to determine the relevant cash flows. 8. Erosion will reduce the sales of existing products. 9. When a firm finances new investments, it may set up accounts payable with suppliers, but the balance that the firm must supply is called the investment in net working capital. 10. The stand -alone principle is the assumption that evaluation of a project may be based on the project's incremental cash flows. 11. When analyzing a proposed investment, we WON’T include interest paid or any other financing costs. 12. Which of the following is an example of a sunk cost? Test marketing expenses 13. Opportunity costs are classified as relevant costs in project analysis. 14. The cash flows of a new project that come at the expense of a firm's existing projects is called erosion. 15. Cash flows should always be considered on a(n) after-tax basis. 16. Investment in net working capital arises when ___. a. cash is kept for unexpected expenditures b. inventory is purchased c. credit sales are made 17. Which of the following are fixed costs? a. rent on a production facility b. cost of equipment 18. Interest expenses incurred on debt financing are ignored when computing cash flows from a project. 19. Operating cash flow is a function of _____. a. depreciation b. taxes c. earnings before interest and taxes (EBIT) 20. Once cash flows have been estimated, which of the following investment criteria can be applied to them? a. payback period b. IRR c. NPV 21. Accounts receivable and accounts payable are not an issue with project cash flow estimation unless changes in net working capital are overlooked. 22. The rules for depreciating assets for tax purposes are based upon provisions in the 1986 Tax Reform Act. 23. An increase in depreciation expense will increase cash flows from operations, because it will decrease taxes paid. 24. The difference between a firm's current assets and its current liabilities is known as the net working capital. 25. A calculated NPV of $15,000 means that the project is expected to create a positive value for the firm and should be accepted if there is no capital rationing constraint. 26. OCF is calculated as net income plus depreciation using the bottom-up approach. 27. While making capital budgeting decisions, which of the following sentence is true regarding the initial investment of net working capital? It is expected to be recovered by the end of the project's life. 28. Using the top-down approach, OCF is calculated by subtracting costs and taxes from sales. 29. The accelerated cost recovery system is a depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications. 30. Which one of the following is the equation for estimating operating cash flows using the tax shield approach? OCF = (Sales - Costs) × (1 - Tax rate) + Depreciation × Tax rate 31. What is net working capital? Current assets minus current liabilities 32. To calculate the OCF using the bottom-up approach, add depreciation to net income. 33. When evaluating cost-cutÝng proposals, how are operating cash flows affected? a. There is an additional depreciation deduction. b. The decrease in costs increases operating income. 34. The winner’s curse says that the lowest bidder is the one who underbid the most. 35. The computation of equivalent annual costs is useful when comparing projects with unequal lives. 36. With cost-cutÝng proposals, when costs decrease, operating cash flows increase. 37. Korporate Classics Corporation (KCC) won a bid to supply widgets to Pacer Corporation but lost money on the deal because they underbid the project. KCC fell victim to the winner’s curse. 38. An asset’s class established its life for tax purposes. 39. When considering Net Working Capital, a project will generally need all of the following, except: Only long-term assets to get the project started.